ABC analysis is the term used in the context of inventory management; it’s helpful to use an ABC analysis to determine which items are the most important as far as the company is concerned. This system sorts items into three categories based on their importance: A, B, and C. Items in category A are the most important and should be tracked carefully. Category B items are less important, but still, need to be monitored. Items in category C can be ignored or tracked less frequently. In order to get a better idea about this concept, one should look at some of the advantages and disadvantages of ABC analysis –
Advantages of ABC Analysis
ABC Analysis leads to Increase in Efficiency
The first and foremost advantage of ABC analysis is that it helps the company in focusing on the most important items. When the company is dealing with a large number of items, it can be difficult to know where to start. With ABC analysis, the company can quickly identify which items are the most important and need to be addressed first. This can help improve the business’s efficiency because the time which was wasted in material management can be saved due to ABC analysis and used by the company to focus on other important tasks.
Identification of Problem Areas
Another advantage of ABC analysis is that it can help the company identify problem areas because by categorization of items the company will know that items under C category are being sold or used less which is an indication of an underlying problem and thus can help the company in identifying the cause of the problem and address it quickly which in turn can save company lot of time and money in the long run.
Better Decision Making
It leads to better decision making on the part of the company because once the company gets the idea about the materials or stocks which are the most important then it can take steps to ensure that the company focuses more on those materials or stocks which in turn will result in less disruption in the production process as the company can plan in advance for the timely availability of category A items for production.
Disadvantages of ABC Analysis
Simplistic in Approach
One of the biggest disadvantages of ABC analysis is that it is too simplistic. This approach does not take into account all of the different factors that could impact the business as well as the products. Hence for example, if the company is selling products that are seasonal, then the company will need to adjust the inventory levels accordingly because in times of peak season sales of seasonal items will be very high which will place them in category A items and during the slack season sales of seasonal items will be very low. Hence in such cases, ABC analysis will be of no use to the company.
Same Category Items
Another disadvantage of ABC analysis is that it can be inaccurate in the sense that this approach assumes that all items in a category are the same, which is often not the case. For example, if you have two products that are both classified as A items, but one item has a higher profit margin and the other item has a lower profit margin then they cannot be placed under the same category.
Time Consuming Process
Another limitation of ABC analysis is that it can be time consuming process. This approach requires a company to break down the sales data or production data into three categories, which can be a lot of work for the company if your data is not already organized in this way. Besides, it can also be difficult to determine the right cutoff points for each category and is prone to subjectivity on the part of the material manager or sales manager.
As one can see from the above that ABC analysis has pros as well as cons and that is the reason why any company thinking of adopting this process into company should carefully read the above points and then only should apply this system of inventory control in the organization.